There are several factors one must consider when determining if payments made are fraudulent preferences under section 95 of the Bankruptcy and Insolvency Act, RSC 1985, c B-3 (the "BIA"). Fortunately the Alberta Court of Appeal has recently handed down a decision that may be of interest to bankruptcy practitioners. In Piikani Energy Corporation (Re), 2013 ABCA 293, the Court of Appeal had to determine if certain payments made by an energy corporation were fraudulent preferences, and in coming to its conclusion the Court touched on the issue of arm's length transactions with directors.
The Piikani Nation (the "Nation"), located in the south-west corner of Alberta, agreed to allow a portion of its lands to be used for the development of the Oldman River Dam. The Piikani Nation received $36.3M in return for entering into the Settlement Agreement. This money was going to flow to other Piikani Business Entities, such as Piikani Energy Corporation (PEC).
On January 1, 2009, PEC entered into a consulting agreement with 607385 Alberta Ltd ("607") pursuant to which 607 would receive an annual fee of $150,000 payable in advance. 607's consulting business is run by Stephanie Ho Lem.
On February 1, 2009, Dale McMullen entered into an employment agreement with PEC.
There were ongoing legal battles between the Nation, PEC and Piikani Investment Corporation (PIC). In October 2009 the Nation applied for the appointment of Alger & Associates Inc. ("Alger") as investigator for PIC. On December 18, 2009, PEC paid 607 its annual retainer for 2010, as well as McMullen's severance payment pursuant to the employment agreement. Three days later the Nation's application to have Alger named as PEC's Interim Conservator was granted by a chambers judge. Alger terminated 607's consulting agreement in July of 2010, and demanded that Ho Lem pay back her unearned portion of 607's 2010 retainer. On November 20, 2012, Alger assigned PEC into bankruptcy.
Alger was successful in its application to have the payments made to 607 and McMullen voided as fraudulent preferences. The chambers judge held that PEC was insolvent when it made the payments to Ho Lem and McMullen, and that they were not at arm's length to PEC. 607 and McMullen appealed.
Issues and Reasoning
At issue on appeal was whether Ho Lem and McMullen were at arm's length to PEC, and whether PEC was insolvent when the payments were made. The term "arm's length" is not defined in the BIA.
Section 95 of the BIA was the relevant section in this matter. This section creates the distinction of arm's length and non-arm's length creditors; this is significant for two reasons: for one, if a transaction occurs between two arm's length parties then the reviewable period before bankruptcy is three months, whereas if the transaction occurs between non-arm's length parties the reviewable period is twelve months. This meant that if Ho Lem and McMullen were found to be at arm's length to PEC then the payments are not reviewable (because they occurred more than three months prior to bankruptcy). Secondly, the current wording of section 95 came into force in September of 2009, and it eliminated the question of intent for preferences between non-arm's length parties.
The chambers judge concluded that directors generally are not at arm's length with the corporations they serve, and therefore Ho Lem and McMullen were not at arm's length with PEC (they were both, at various times, directors and officers of PEC and PIC). The Court of Appeal found that the chambers judge erred in several ways when coming to his conclusion.
For one, the chambers judge refused to look at any decision discussing the meaning of arm's length transactions in the context of the Income Tax Act, RSC 1985, c 1 (5th Supp) (the "ITA"). Instead the chambers judge concluded that the definition of "arm's length" for the purposes of the BIA was more closely related to the concept of insiders under the Securities Act, RSA 2000, c S-4. The Court of Appeal disagreed stating that the "concept of 'insider' is qualitatively different from the concept of an 'arm's length' person" (at para 20). Instead the Court of Appeal concluded that the ITA does provide appropriate principles for determining whether parties are dealing at arm's length.
The Court of Appeal looked at the historical usage of the terms "control" and "arm's length" in legislation, concluding that Parliament must have intended that those terms have the same meaning in the BIA as in the ITA given that they have almost identical wording. Furthermore, key cases that contemplated the definition of "arm's length" in the context of the BIA used the ITA for guidance. The Court of Appeal found that "defining arm's length consistently [...] accords with the view that courts may consider the legislature's 'statute book' in giving meaning to a term. This approach relies on the logical presumption that Parliament knows what other statutes say when it passes an enactment" (at para. 26). The Court of Appeal endorsed Rothstein J's approach in McClarty v R, 2008 SCC 26 (McClarty), where it was held that "a court must consider all the relevant circumstances to determine if the parties in a transaction are at arm's length" and pointed to three useful criteria for making that determination (at para. 29):
i. was there a common mind which directs the bargaining for both parties to a transaction;
ii. were the parties to a transaction acting in concern without separate interest; and
iii. was there de facto control.
Finally, the chambers judge found it difficult to see how it was possible that "decisions-makers could be at arm's length to the [a] corporation when they make payment decisions, especially to themselves" (Piikani Energy Corporation (Re), 2012 ABQB 187 (CanLII), at para. 129). In response the Court of Appeal cited several decisions which support the position that being a director of a company does not necessarily mean that one is not at arm's length with the company (at paras. 31-34). Again, similar to the three criteria mentioned in McClarty (above), it depends on the degree of control or influence and whether interests are aligned. Furthermore the Court of Appeal pointed to the Business Corporations Act, RSA 2000, c B-9 (the "BCA"), which recognizes that it is not always the case that a director is not at arm's length with the corporation they serve (referring to section 102(6) of the BCA). "So long as the corporation is represented by independent individuals, the director would be dealing at arm's length [...]" (para. 35).
The Court of Appeal concluded, on the facts, that Ho Lem and McMullen were at arm's length to PEC, and therefore the payments were not reviewable pursuant to section 95 of the BIA (because the payments occurred outside the three-month period). In addition to the error's regarding the law with respect to the arm's length determination, the chamber's judge also incorrectly believed that Ho Lem and McMullen constituted 50% of the Board of PEC when in fact they were two of five directors (therefore had less than 50% control). Since both Ho Lem and McMullen were found to have dealt with PEC at arm's length, it was not necessary to consider whether PEC was in fact insolvent at the time of the payments, nor was it necessary to consider whether the payments were fraudulent preferences.
The takeaway from the Pikani decision is this: when making a determination regarding whether certain dealings between parties occurred at arm's length, one needs to look at the totality of the circumstances, using the criteria from McClarty and the jurisprudence under the ITA as a guide. An arm's length determination is central to determining whether payments made were fraudulent preferences under the BIA, and it is not always the case that directors are not at arm's length with the corporations they serve. Intent to grant a preference is no longer a requirement under the BIA.
An Associate here at Davis LLP, Ms. Karen Fellowes, acted on behalf of 607 in this matter.
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